We maintain our UNDERWEIGHT rating on the sector which is expected to be dull in terms of earnings growth and further capped by expensive valuations. In fact, overall 3Q17/9M17 results also came in below expectations. Specifically, 3QCY17 results season saw both Pharmaniaga (PHARMA) and IHH Healthcare (IHH) coming in below expectations while KPJ Healthcare (KPJ) barely met expectations. IHH’s results marked the third consecutive quarterly earnings disappointment, hit by ramp-up of hiring and pre-operating costs to prepare Gleneagles Hong Kong Hospital and Acibadem Altunizade Hospital and unrealised foreign exchange loss of non-Turkish Lira borrowings. PHARMA was hit by higher-thanexpected operating cost. All in, healthcare stocks under our coverage are trading at rich PER valuations in contrast to their expected low-teens earnings growth. We believe their growth potentials are already reflected in the valuations. To reiterate, the main drawback at this juncture is that healthcare stocks including IHH (UP, TP: RM5.00) and KPJ (MP, TP: RM1.00) are trading at rich valuations while offering low dividend yields.

Weak 9M17 results and pedestrian growth while longer-term growth supported by ageing population. Overall 3Q17/9M17 results came in below expectations. Specifically, 3QCY17 results season saw both Pharmaniaga and IHH coming in below expectations while KPJ barely met expectations. IHH’s results marked the third consecutive quarterly earnings disappointment, hit by ramp-up of hiring and pre-operating costs to prepare Gleneagles Hong Kong Hospital and Acibadem Altunizade Hospital and unrealised foreign exchange loss of non-Turkish Lira borrowings. Pharmaniaga was hit by higher-thanexpected operating cost. Over the longer term, growth is expected to be supported by an ageing population and growing awareness in healthcare maintenance and disease prevention. It is estimated that during the 2010-2040 period, Malaysian population aged 65 and over will increase to more than three-fold the 2010 population. The increase will categorise Malaysia as an aging population society in 2021 when the population aged 65 years and above reach 7.1%. Based on the United Nations (UN)’s definition, an aging society is when the population aged 65 and over constitutes 7% of the total population. Population for the age group 0–14 years is projected to decline from 27.4% to 19.6% for the same period. However, the population for the age group 15– 64 years and 65 years and over is expected to increase by 1.4 and 6.4 percentage points, respectively, for the same period. Longer life spans will also result in a larger number of people aged 65 and above. This improvement is attributed mainly to advances in medical technology, higher personal wealth and growing awareness of the importance of healthcare maintenance and disease prevention.

IHH missed consensus earnings for two successive quarters. The stock is expected to continue to be de-rated and weighed down by marked-to-market volatility on translation of non-Turkish Lira borrowings. Overall, over the short-to-medium term, a slower-than-expected economic outlook and start-up costs on pre-opening of hospitals, including Gleneagles Hong Kong which has just recently commenced operations are expected to put pressure on cost and margins at least over the short term. Growth drivers in the next five years will come from the following:- (i) In Malaysia, PPL is currently undertaking expansion projects in three hospitals, namely Pantai Hospital Ayer Keroh (160 beds, completion in 2019), Pantai Hospital Klang (120 beds), Pantai Kuala Lumpur (120 beds, completion in end 2017). Greenfield projects meanwhile, namely Gleneagles Chengdu (350 beds, completion in end 2018), Gleneagles Nanjing (70 beds , completion in end 2019), Gleneagles Shanghai (450 beds , completion in end 2019) and (ii) in Turkey, Acibadem is currently undertaking expansion in Acibadem Maslak (200 beds, target completion 2018). The greenfield projects are Acibadem Altunizade (180 beds, target completion mid-2017), Acibadem Atasehir (325 beds, target completion 2018) and Acibadem Kartal (120 beds, target completion 2018).

KPJ valuation looking stretched as well. We continue to reiterate our MARKET PERFORM recommendation because of: (i) rich valuations compared to its pedestrian net profit growth over the next two years. The stock is currently trading at PER of 25x for FY18E and 23x for FY19E, which appear rich as compared to its pedestrian growth for the two financial years. Going forward, KPJ Perlis (greenfield, 90 beds) and KPJ Seremban (new block with additional 90 beds) are expected to commence operations by early 1Q18. Elsewhere, brownfield expansions include Taiping, Sri Manjung and KPJ Johor Bandar Dato Onn, which are expected to operate by early 2018. We expect performance in Indonesia to continue to remain volatile over the next several quarters due to lower bed utilisation of 40%.

Bleak short-term earnings outlook for PHRM. We expect earnings to be lukewarm in subsequent quarters in anticipation of volatile off-take and potential higher operating expenses. Additionally, the roll-out of PHIS is expected to continue to dampen bottom-line over the short-term. Over the longer-term, we expect its manufacturing division to propel earnings. The group aims to add about 200 new products over the next 10 years to its existing portfolio of around 500 products, which should boost demand for its products and lift earnings.

Source: Kenanga Research - 5 Jan 2018